To remain competitive, companies find themselves increasing their efforts to digitally transform their businesses by developing new offerings based on emerging technologies and integrating these technologies into existing product and service offerings.
This is our eighth monthly bulletin for 2020, aiming to help companies identify important and significant legal developments governing the use and acceptance of blockchain technology, smart contracts and digital assets.
While the use cases for blockchain technology are vast, from copyright protection to voting, most of the current adoption is in the financial services section and the focus of this bulletin will be primarily on the use of blockchain and or smart contracts in that sector. With respect to digital assets, we have organized our approach to this topic by discussing it in terms of traditional asset type or function (although the types and functions may overlap), that is, digital assets as:
- Virtual currencies
- Deposits, accounts, intangibles
- Negotiable instruments
- Electronic chattel paper
- Digitized assets
Digital assets can themselves be assets or instead can reflect the ownership of an underlying asset. For example, electronic records that are the equivalents of negotiable instruments and electronic chattel paper would be digital assets, as would an electronic recording of a security interest in the underlying asset, such as recording title to real or personal property and the use of tokens to represent revenue streams from otherwise illiquid assets such as patents and commercial real estate (sometimes referred to as a “tokenized” or digitized asset).
In addition to reporting on the law and regulation governing blockchain, smart contracts and digital assets, this bulletin will discuss the legal developments supporting the infrastructure and ecosystems that enable the use and acceptance of these new technologies.
Each issue will feature in-depth insight on a timely and important current topic. In this issue, we review the recent Coinbase decision and its impact on cryptocurrency exchanges.
To build on our recent increasing recognition in the fintech and blockchain space, DLA Piper’s IPT and Real Estate teams have joined up to contribute to the inaugural edition of the Chambers and Partners Blockchain Guide 2020. Led by partner Scott Thiel and supported by Jonathan Gill and Kenny Tam, the team wrote the Hong Kong and China “Law and Practice” sections of the guide discussing the blockchain market and noting key legal and regulatory issues in each jurisdiction.
For related information regarding digital transformation, please see our monthly bulletin, eSignature and ePayment News and Trends.
California appellate court affirms judgment for Coinbase in lawsuit over Bitcoin Gold
On August 10, the California First District Court of Appeals affirmed summary judgment for Coinbase in a lawsuit brought by a customer who alleged that Coinbase had wrongfully failed to provide support for or access to the Bitcoin Gold fork. The court held that the plaintiff failed to identify a breach by Coinbase of its user agreement and that the agreement between the parties precluded the plaintiff’s tort claims. Read more.
- National banks may provide cryptocurrency custody services – exchanges will soon face competition. On July 22, the Office of the Comptroller of the Currency (OCC) issued Interpretive Letter #1170 concluding that national banks and federal savings associations have the authority to provide cryptocurrency custody services for their customers, including holding the unique cryptographic keys associated with the cryptocurrency. The bank or savings association must still implement appropriate controls and systems to mitigate risk, and otherwise comply with applicable law. Read more.
- FINRA issues regulatory notice on digital asset activities. On July 9, the Financial Industry Regulatory Authority (FINRA) issued regulatory notice 20-23, Digital Assets – FINRA Encourages Firms to Notify FINRA if They Engage in Activities Related to Digital Assets. The notice encourages its member firms’ continued cooperation in promptly notifying FINRA, through July 31, 2021, if the firm, or its associated persons or affiliates, engage, or intend to engage, in activities related to digital assets. Such activities may include purchases, sales, investments or transfers in digital assets, pooled funds related to digital assets or derivatives tied to digital assets, as well as offerings of digital asserts or custody arrangements. The request applies to digital assets, including cryptocurrencies and other virtual coins and tokens, whether or not they meet the definition of a “security” for purposes of the federal securities laws or FINRA rules.
- Federal Reserve publishes results of DLT experimentation. On August 13, staff of the Federal Reserve Board published Observations from the FooWire Project: Experimenting with DLT for Payments Use. The FooWire Project was a small-scale experiment seeking to build a payment system using distributed ledger technology (DLT). The experiment highlighted the potential of DLT for certain payment uses, the quick speed with which a system may be implemented, the potential simplicity of smart contracts, and the range of functionality offered by such platforms. It further highlighted the need for more experimentation to better understand the possibilities for wide-scale adoption and use of any DLT platform for payments.
- National Taxpayer Advocate criticizes IRS soft letters to virtual currency taxpayers in report to Congress. On June 29, the National Taxpayer Advocate, head of the Office of the Taxpayer Advocate Service (TAS) of the IRS, published the Objectives Report to Congress Fiscal Year 2021. The Report includes a section entitled Protecting the Rights of Taxpayers Who Receive ’Soft Letters’ That Require Them to Provide Support for Their Return Positions and Sworn Statement Outside an Examination. In this section, the National Taxpayer Advocate stated that recent IRS soft letters, such as Letter 6173 directed to taxpayers who had reportable virtual currency transactions, include language aimed at compliant taxpayers requiring them to produce documents and a detailed supporting statement signed under penalties of perjury; and may cover more than one tax period, request information not included on a return, and possibly cover years outside of the statute of limitations for assessment. The National Taxpayer Advocate’s position is that the requests in these letters are “intrusive,” “violate taxpayers’ rights and should not appear in any soft letters or communications outside the examination process.”
- SEC Commissioner Peirce speaks on the Telegram decision. On July 21, SEC Commission Hester Peirce spoke at Blockchain Week at the behest of the Blockchain Association Singapore. In her presentation, she reviewed in detail her concerns regarding the global implications of the decision of the Southern District of New York in the case of SEC v. Telegram Group Inc.
- CFTC holds Technology Advisory Committee meeting. On July 16, the Commodity Futures Trading Commission held an online Technology Advisory Committee (TAC) public meeting. At the meeting, the subcommittee on Distributed Ledger Technology (DLT) and Market Infrastructure discussed the increased interest in DLT and different design considerations as well as impediments to implementation, provided examples of how digital tokens are being used by various industries. The subcommittee on virtual currencies presented an overview of Central Bank Digital Currency (CBDC) design considerations and privacy concerns and discussed the volatility of bitcoin as compared to stocks.
- FinCEN publishes advisory on COVID-19 cybercrime. On July 30, the Financial Crimes Enforcement Network (FinCEN) issued an Advisory on Cybercrime and Cyber-Enabled Crime Exploiting the Coronavirus Disease 2019 (COVID-19) Pandemic, warning that cybercriminals are exploiting COVID-19 through malware, phishing schemes, extortion, business email compromise fraud and exploitation of remote applications. The advisory notes the schemes may offer investments in convertible virtual currencies or demand ransoms in the form of virtual currency. It alerts financial institutions dealing in virtual currency to be aware of the potential use of their institutions to launder proceeds affiliated with cybercrime. The advisory also provides additional instructions for filing Suspicious Activity Reports (SARs) related to such activities.
- New York Federal Reserve Bank analyzes distinctions between digital currencies. On August 12, Federal Reserve analysts discussed the distinctions between “account-based” and “token-based” digital currency systems. The analysts conclude that the distinctions between the classifications have limited value in that most digital currencies, including bitcoin and CBDCs, possess characteristics of both.
- Federal Reserve Board Governor discusses use of central bank digital currencies. On August 13, Lael Brainard, a member of the Federal Reserve’s Board of Governors (FRB), spoke on an Innovation Hours webcast and provided an update on the FRB’s thinking regarding the use of digital currencies, and specifically CBDCs. Governor Brainard began by noting that the FRB is conducting research regarding the use of digital currencies and distributed ledger technologies, including to assess the opportunities, challenges, and use cases of a CBDC. The Federal Reserve Bank of Boston is collaborating with the Massachusetts Institute of Technology to build and test a hypothetical digital currency oriented to central bank uses. Governor Brainard noted, however, that a significant policy process would be required before considering the issuance of a CBDC, and legal considerations would also need to be addressed, such as whether a CBDC would have legal tender status. Further, Governor Brainard noted that the FRB continues to learn from other central banks – a poorly designed CBDC in one jurisdiction could create financial stability issues in other jurisdictions.
- Louisiana requires persons engaging in virtual currency business to be licensed: On June 13, the governor of Louisiana signed into law the Virtual Currency Business Act, which requires a person engaged in “virtual currency business activity” to be licensed or registered if the business meets certain criteria. “Virtual currency business activity” is broadly defined and includes:
- Exchanging, transferring, or storing virtual currency or engaging in virtual currency administration, whether directly or through an agreement with a virtual currency control services vendor.
- Holding electronic precious metals or electronic certificates representing interests in precious metals on behalf of another person or issuing shares or electronic certificates representing interests in precious metals.
- Exchanging one or more digital representations of value used within one or more online games, game platforms, or family of games for either of the following:
- Virtual currency offered by or on behalf of the same publisher from which the original digital representation of value was received.
- Legal tender or bank credit outside the online game, game platform, or family of games offered by or on behalf of the same publisher from which the original digital representation of value was received.
- New York DFS publishes greenlist of virtual currency. On August 3, the New York Department of Financial Services (DFS) published a greenlist of all virtual currencies that have been pre-approved for use in virtual currency business activity in New York. For more information, see our July issue.
- Pennsylvania adopts Revised Uniform Fiduciary Access to Digital Assets Act. On July 23, Pennsylvania adopted SB 320 the Revised Uniform Fiduciary Access to Digital Assets Act (RUFADAA), modernizing the state’s digital access and disclosure laws and providing guidance for individuals to transfer their digital assets or for their executors, trustees, powers of attorney, or guardians to access their digital assets. The RUFADAA gives fiduciaries the authority to access an individuals’ digital assets or electronic communications and provides a framework for custodians of digital assets and electronic communications (eg, social media and email platforms) to safely disclose an individual’s digital assets and communications to a fiduciary.
- SEC charges issuer and CEO in fraudulent ICO. On August 13, the SEC announced charges against Virginia-based Boon.Tech and its CEO Rajesh Pavithran for fraud and registration violations in connection with a $5 million initial coin offering (ICO) of digital asset securities. According to the SEC’s order, from November 2017 to January 2018, Boon.Tech and Pavithran raised approximately $5 million by selling Boon Coins to more than 1,500 investors in the US and worldwide to raise funding to develop and market a platform to connect employers posting jobs with freelancers seeking work. The SEC’s order finds that Boon.Tech and Pavithran violated the antifraud and registration provisions of the federal securities laws. Without admitting or denying the SEC’s findings, Boon.Tech and Pavithran agreed to settle the charges by consenting to the issuance of the order, which requires Boon.Tech to disgorge the $5 million raised in the ICO plus prejudgment interest of $600,334. The order further requires Boon.Tech and Pavithran to destroy all Boon Coins in their possession, issue requests to remove Boon Coins from any further trading on all third-party digital asset trading platforms, and refrain from participating in any future offerings of digital asset securities. Further, the order requires Pavithran to pay a penalty of $150,000 and bars him from serving as an officer or director of a public company.
- DOJ seizes cryptocurrency from terrorism funding groups. On August 13, the Department of Justice announced the government’s largest-ever seizure of cryptocurrency in the terrorism context – dismantling three terrorist-financing cyber-enabled campaigns involving the al-Qassam Brigades (the military wing of Hamas), al-Qaeda, and the Islamic State of Iraq and the Levant (ISIS). The three terrorist-financing campaigns relied on sophisticated cyber-tools, including solicitation of cryptocurrency donations from around the world. Pursuant to judicially authorized warrants, US authorities seized millions of dollars, over 300 cryptocurrency accounts, four websites and four Facebook pages related to the enterprise.
- OFAC sanctions Chinese nationals for using cryptocurrency to launder proceeds from illicit drug transactions. On July 17, the US Office of Foreign Assets Control, a division of the Treasury Department, announced the designation under the Foreign Narcotics Kingpin Act of four Chinese nationals and Global Biotechnology Inc. for supporting the Zheng Drug Trafficking Organization. OFAC alleges the Zheng DTO laundered its drug proceeds in part by using digital currency such as bitcoin, transmitted drug proceeds into and out of bank accounts in China and Hong Kong, and bypassed currency restrictions and reporting requirements.
- DOJ announces charges in Twitter hack. On July 31, the DOJ announced that three individuals were charged for their alleged roles in the Twitter hack that occurred on July 15 in which the social media accounts of certain high-profile individuals, such as politicians, celebrities and musicians, were hacked in a scheme to solicit bitcoin. The scheme received more than $100,000 in bitcoin from over 400 victims. Mason Sheppard of the United Kingdom was charged in the Northern District of California with conspiracy to commit wire fraud, conspiracy to commit money laundering and the intentional access of a protected computer. Nima Fazeli of Florida was also charged in the Northern District of California with aiding and abetting the intentional access of a protected computer. The third individual is a juvenile; that case is sealed.
- DOJ files complaint to forfeit more than $6.5 million in cryptocurrency. On July 29, the DOJ announced that the US filed a complaint to forfeit approximately 480 bitcoins and more than 1.7 million tether (collectively worth $6.5 million) stolen in the so-called Banana Fund Ponzi scheme. The complaint alleges that the administrator of the “Banana Fund” marketed the company to potential investors as a platform for startups to post business proposals and receive crowdfunding in virtual currency. Based on the administrator’s representations, his victims sent him investment contributions; however, the Banana Fund never became operational. Instead, the administrator invested the victims’ capital for his own gain. After admitting that the Banana Fund was unsuccessful, he told his victims that he would return their contributions. When he failed to do so, US authorities seized the remaining victim funds, which amounted to more than $6.5 million in bitcoins and tether.
- California man pleads guilty to operating unlicensed bitcoin ATM network. On July 22, the US Attorney’s Office for the Central District of California announced that Kais Mohammad, AKA Superman29, agreed to plead guilty to federal criminal charges that he operated an illegal virtual currency money services business under the name Herocoin that exchanged up to $25 million through in-person transactions and a network of bitcoin ATM kiosks. Mohammad faces a maximum of 30 years in federal prison and, as part of the plea agreement, has agreed to forfeit cash, cryptocurrency and the 17 bitcoin ATMs he operated.
- New York man charged with running $4.5 million cryptocurrency scheme. On July 9, the US Attorney’s Office for the Northern District of California announced that it had charged Douglas Jae Woo Kim with wire fraud in connection with a bogus multimillion-dollar cryptocurrency investment scheme. According to the complaint and affidavit, Kim claimed that he was a cryptocurrency trader and requested short-term business loans from friends and acquaintances totaling $4.5 million. However, Kim allegedly used cryptocurrencies to finance transactions in the scheme and then transferred some or all of his victims’ assets to online gambling sites outside the United States.
- Longfin investors granted default judgment. On July 29, the US District Court for the Southern District of New York entered a default judgment in the case of In Re Longfin Corp. Securities Class Action Litigation, holding that Longfin, its CEO Venkata Meenavalli, its CFO Vivek Ratakonda, and Suresh Tammineedi together owe more than $223 million plus pre- and post-judgment interest. For more information on the SEC cases related to Longfin, see our February issue.
- Third Centra Tech co-founder pleads guilty in ICO fraud scheme. On July 17, the US Attorney’s Office for the Southern District of New York announced that Sohrab “Sam” Sharma, a co-founder of Centra Tech Inc., pled guilty to conspiring to commit securities and wire fraud in connection with a scheme to induce investment of more than $25 million to purchase digital tokens issued by Centra Tech through an initial coin offering in 2017. Sharma is facing up to seven years in prison. For more information, see our July issue.
- Quebec trio charged with running fraudulent cryptocurrency. On July 24, the US Attorney’s Office for the Northern District of Ohio announced the return of a five-count indictment charging three Quebec nationals with conspiracy to commit securities fraud and wire fraud, wire fraud and conspiracy to commit money laundering. According to the indictment, from May 2017 to December 2017, the defendants conspired together to induce investors to purchase PlexCoin in a 2017 ICO of an entity known as PlexCorps. The indictment states that the defendants made numerous false claims about PlexCorps and PlexCoin to potential investors, and investors purchased approximately $8 million worth of PlexCoin in the ICO. Court documents show that the defendants and their co-conspirators regularly transferred investor funds from the PlexCoin ICO into fiat currency accounts, and cryptocurrency addresses belonging to themselves for the purpose of daily living expenses and home renovation products.
- Texas securities regulator issues cease-and desist-order. On July 7 and 8, the Texas State Securities Board (TSSB) issued an emergency cease-and-desist order against Liquidity Gold Trust and related entities and their founder, Lance Angus Jerrard, for engaging in a cryptocurrency debit card scheme by offering the investments on social media, internet sites and ads on an Austin radio station. The fraudulent scheme seeks investors to purchase a “Liquidity Card” debit card which allegedly enables cardholders to move profits into an account that works with stablecoins to avoid taxable events. Jerrard and the Liquidity entities were not registered with the TSSB as dealers or agents.
- Washington, DC court holds bitcoin is money. On July 24, the US District Court of the District of Columbia issued a memorandum opinion in the case of US v. Larry Dean Harmon, Criminal Action No. 19-395 (BAH), denying Harmon’s motion to dismiss by finding that bitcoin constitutes “money” for purposes of the DC Money Transmitters Act (MTA) and that Harmon operated an unlicensed “money transmitting business” under federal law. Harmon was charged with three counts related to his operation of Helix, an underground “tumbler” for bitcoin, enabling customers, for a fee, to send bitcoins to recipients in a manner which concealed the source or owner of the bitcoin. The court noted that the MTA failed to define the term “money” so the court adopted the term’s ordinary meaning as “a medium of exchange, method of payment, or store of value.”
SPOTLIGHT ON INTERNATIONAL DEVELOPMENTS
- Canadian securities regulator accuses Coinsquare of inflating trading volumes. On July 22, the Ontario Securities Commission (OSC) announced it approved a settlement agreement with Coinsquare Ltd., Cole Diamond, Virgile Rostand and Felix Mazer, based on a July 16 statement of allegations alleging that the respondents knowingly engaged in market manipulation by conducting and reporting inflated trade volumes through fake or “wash” trading activity, and took a reprisal action against an internal whistleblower. The OSC alleges the fake trades represented 90 percent of Coinsquare’s reported volume between July 2018 and December 2019, with an aggregate value of around 590,000 bitcoin. Under the settlement agreement Diamond and Rostand agreed to resign and pay administrative penalties of $1 million and $900,000, respectively. Mazer also resigned and made a voluntary payment of $50,000 to the OSC. Coinsquare is required to implement substantial corporate governance improvements.
- Chinese Supreme Court issues guidelines on ownership rights in digital assets. On July 22, the Supreme People’s Court of China published a guideline which includes recommendations for the Chinese legal system to enhance protections over new types of ownership rights such as digital currencies and online virtual assets.
- Chinese police arrest executives in PlusToken scam. Reportedly, on July 30, Chinese police arrested 27 key executives and 82 additional individuals for their involvement with the cryptocurrency scheme PlusToken. PlusToken originally launched as a South Korea-based cryptocurrency exchange offering high investor returns. When users were unable to withdraw funds, PlusToken was exposed as having defrauded investors of nearly $6 billion.
- European accounting advisory group publishes paper on reporting of crypto-assets. In July, the European Financial Reporting Advisory Group (EFRAG) published Accounting for Crypto-Assets (Liabilities): Holder and Issuer Perspective, a discussion paper offering approaches to address gaps in crypto-assets in the International Financial Reporting Standards. EFRAG seeks comments on its findings which must be submitted by July 31, 2021.
- Malaysian securities regulator seeks feedback on framework for digital asset wallet providers. On July 23, the Securities Commission Malaysia (SC) announced that it seeks industry feedback on the proposed regulatory framework for digital asset wallet providers which will complement the existing frameworks for Digital Asset Exchange (DAX) and Initial Exchange Offering (IEO). Interested parties were requested to contact the SC for an engagement session and/or to provide any feedback not later than August 14. Once finalized, the regulatory framework for digital asset wallet providers will be included as part of the Guidelines on Digital Assets.
- Russian Duma passes bill on cryptocurrencies. On July 22, the Duma, the Russian Federation’s legislative body, reportedly passed a bill entitled On Digital Financial Assets which provides a legal definition for digital assets and legitimizes cryptocurrency trading in Russia. However, the bill prohibits the use of cryptocurrencies as a payment method. A separate bill, “On Digital Currency,” which is still under consideration by the Duma, will set forth the framework for crypto industry regulation.
- Singapore Monetary Authority reports on blockchain payments network project. On July 13, the Monetary Authority of Singapore announced the release of a report marking the successful conclusion of the fifth and final phase of Project Ubin, a blockchain-based, multi-currency payments network project. The report, entitled Project Ubin Phase 5: Enabling Broad Ecosystem Opportunities, examines the use of blockchain technology in commercial applications across different industries, and how these applications could benefit from integrating with the blockchain-based payments network prototype developed. These benefits were validated through workshops conducted with more than 40 financial and non-financial firms engaged in Phase 5 of Project Ubin.
- Singapore Monetary Authority issues consultation seeking input on regulation of VASPs. On July 21, the Monetary Authority of Singapore issued a Consultation Paper on a New omnibus Act for the Financial Sector regarding the introduction of a new financial sector law which includes provisions regulating virtual asset service providers (VASPs) for anti-money laundering and countering of financial terrorism. The consultation seeks feedback on the new provisions by August 20.
- UK Treasury issues consultations seeking feedback on oversight of cryptoassets. On July 20, the UK’s HM Treasury announced it is soliciting comments on two consultations. The first modifies regulations for promotion of financial products to require firms authorized by the Federal Conduct Authority (FCA) to obtain the prior consent of the FCA to approve the promotions of unauthorized firms. The second consultation brings certain “qualifying cryptoassets” under the scope of FCA financial promotions regulations, and defines “qualifying cryptoasset” as “any cryptographically secured digital representation of value or contractual rights that uses a form of distributed ledger technology and which — (a) is fungible; (b) is transferable or confers transferable rights, or is promoted as being transferable or as conferring transferable rights; (c) is not any other controlled investment as described in this Part; (d) is not electronic money within the meaning given in the Electronic Money Regulations 2011; and (e) is not currency issued by a central bank or other public authority.” Feedback on the consultations is due on October 25.
- World Bank reports on impact of smart contracts on financial systems. On July 13, the World Bank released a report, Smart Contract Technology and Financial Inclusion, which reviews smart contracts coded on blockchain technology and their impact on the development of global financial systems. The report includes an overview of policy considerations related to the deployment of smart contracts and concludes with an analysis of the technology’s potential in the retail and finance industries. The report recommends regulators focus on the impact of smart contracts in accommodating financial consumer protection, KYC/AML compliance and legal foundation requirements.